With 2016 fast approaching, advisors are now planning year-end meetings with their high-net-worth clients. Because so many of these individuals support charities, many advisors will recommend a philanthropic vehicle as part of their overall wealth management strategy. For some advisors, the default choice is a donor-advised fund. After all, they’re fast, easy and solve the immediate need. Plus, they require minimal ongoing effort from the client to manage.
While DAFs are a great option, a private foundation could be a better choice. Unfortunately, a private foundation is often not considered unless the client specifically asks about it. That’s because many financial advisors believe that a private foundation is inherently expensive, complicated and time-consuming, both to set up and to manage. Many contend that, unless the client is going to fund it with at least $5 million, it just doesn’t make sense.
That was true 20 years ago, but not today.
Times and private foundations have changed. Private foundations can be established quickly, often with $250,000 or less, and, thanks to the advent of outsourced management firms, they can be administered simply and at low cost, making them as easy as a DAF but with some potentially important advantages:
A private foundation is a legal entity controlled by the founder.
Many high-net-worth individuals are particularly concerned with maintaining control of their hard-earned assets. Happily, private foundations provide complete control. Unlike a donor-advised fund, where donors cede control when they deposit funds into their giving account, a private foundation is a freestanding legal entity can be 100% controlled by the donor. You and your client decide how the money is invested — not the board of another charity.
Your client can fund the private foundation with a wide array of assets.
Private foundations may own nearly any type of asset, including partnerships, real estate, jewelry, closely held stock, stock options, art, insurance policies and other valuables. A donor-advised fund may limit investment options to cash equivalents, publicly traded securities and shares of mutual funds. Donations of real property and other nonmarketable securities typically are sold or liquidated by the sponsor of the donor-advised fund.
By donating highly appreciated stock to their foundation, clients can bypass capital gains and have the full fair market value of the asset grow tax free, ultimately benefitting charities. As long as the foundation complies with the prudent investor rules, the foundation can keep that stock as long as long as the client likes. The same is true of privately held stock. Many HNW individuals are business executives or entrepreneurs who built the companies in which they hold stock. They like having the option to donate and maintain their privately held stock position (or perhaps a portion of it) for the benefit of their favorite charities.
Private foundation set-up can be as fast and easy as that of a donor-advised fund.
Specialized firms can establish a private foundation in as little as three business days, and set-up fees are typically very affordable.
The entry point is much lower than it used to be.
Technology and the economies of scale afforded by outsourcing have dramatically lowered the costs of running a private foundation. Whereas the asset threshold for a private foundation used to be measured in millions, it can now make sense to start a foundation with $250,000 or less. Today, 67% of all private foundations have less than $1 million in assets.
Your client can be reimbursed for expenses incurred while carrying out foundation activities.
Another differentiator is that foundation members may pay for reasonable and necessary expenses associated with running the foundation. With a donor-advised fund, this is not an option, and there are no means of reimbursing legitimate charitable expenses. Expenses that may be reimbursed by the foundation include board meetings, administration, site visits, travel expenses and even costs associated with starting the foundation. As long as expenses help achieve the foundation’s charitable purpose, they count toward the foundation’s 5% minimum distribution requirement
Foundations enjoy a world of giving options.
Gifts from a donor-advised fund are typically restricted to straightforward donations to U.S.-based 501(c)(3) public charities. Private foundations provide many more avenues to achieve the donor’s philanthropic goals, including:
• Funding tax-exempt organizations that are not 501(c)(3) entities
• Making grants directly to individuals and families facing hardship, emergencies or medical distress
• Supporting charitable organizations based outside the U.S.
• Making loans, loan guarantees and equity investments
• Providing funding to for-profit businesses that support the foundation’s charitable mission
• Setting up and running scholarship and award programs
• Running their own charitable programs
Foundations are entitled to hire staff, including family members.
State and federal regulations allow foundations to pay a salary to family members to provide services to the foundation — as long as these individuals are qualified for the position, the compensation is reasonable and necessary, and the foundation follows the rules governing compensation to insiders. This is not possible with a donor-advised fund.
Your client can negotiate and enforce grant agreements.
It’s commonplace for private foundations to enter into an agreement with their grantees setting forth the purpose, terms and conditions of their grant. Subsequent grant payments are often tied to benchmarks of progress. Donor-advised funds offer no such option, so your client has little control over how the grantees use their funds. If your client intends to make major gifts and has firm views about how the money will be used, this differentiating factor could be critically important.
Your client’s name is on the check, and he or she can hand-deliver it.
Creating a family legacy of giving is one of the rewards of philanthropy. With a private foundation, the name of the donor’s foundation, often the family name, is at the top of the grant check, providing well-earned recognition for the financial support. And if your client prefers to personally deliver a grant check to the organization, be it a fundraising event or a recognition dinner, that’s easy to do.
However, it’s simply not an option with a donor-advised fund because the donor is not an agent of the sponsoring organization and therefore cannot be given control over the execution of grants.
A private foundation can unify a family.
By nature, private foundations are collaborative enterprises. They exert a unifying force, similar to a family business, by erecting a formal structure that links several generations working together toward a common philanthropic goal. By providing a reason to meet and converse, they are the glue that holds together family members, even if they are geographically dispersed. The cohesive board structure of a private foundation simply doesn’t translate to a donor-advised fund, which permits any named advisor to make grant recommendations.
This makes a private foundation an ideal mechanism to train the next generation for the responsibilities of wealth. One concern that advisors often hear, especially from first-generation wealth creators, is that their children, raised in affluence, won’t grow up with the same drive and values as their parents. Private foundations serve as excellent forums for transmitting values, establishing altruistic behavior, and imparting valuable business skills. Younger family members may be directly engaged in the governance, decision making, and day-to-day activities of running the foundation. Through this active participation, they acquire skills in financial management, leadership, communications, teamwork and planning.
Although many people associate the term “private foundation” with the large and venerable institutions that have achieved great benefits for society over the decades, outsourcing has brought the private foundation within reach of hundreds of thousands of American families. It certainly makes sense to explore with your clients how this powerful and versatile vehicle could be the best choice for their philanthropy.
Robert Chartener is CEO of Foundation Source, a firm that provides administrative services, online foundation management tools and philanthropic advisory services to private foundations.
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